Whether it’s to release working capital to add new inventory, or to ensure operational continuity, businesses will always require financing to reach their potential.
Asset Based Lending (ABL) and Supply Chain Finance (SCF) are two distinct working capital solutions that can coexist to comprehensively manage the liquidity needs of companies.
ABL is any kind of loan that is secured by an asset, most commonly receivables and inventory. It is a senior secured financing structure that is routinely funded by global banks and commercial finance companies, typically with hard limits both in terms of amount and tenor. Advances could range from 70-90% of eligible receivables and 50-70% of inventory, though these would vary depending on the inventory type.
By pledging receivables and inventory, ABL allows borrowers to accelerate cashflow and respond to an increase in product demand and growth.
While it’s a less risky proposition for the lender as it is self-liquidating in the event of a default, there are downsides for the borrower. ABL facilities are determined by the company’s receivables and inventory. Advance rates and eligibility are set by the lender and are often conservative and subjective particularly on inventory valuation.
The short falls of ABL can be solved with a Supply Chain Finance program to optimize payables.
SCF is a funding arrangement that works alongside credit facilities to create additional liquidity through trade payables.
It is a working capital program where a finance provider will pay suppliers upon shipment of their goods, while simultaneously offering credit to a buyer for an extended period, allowing them to sell the goods and also maintain a robust cash flow.
In doing this the corporate is able to achieve its balance sheet objectives while not leaving suppliers high and dry. By offering sight payments, and eliminating the risk of buyer default, they are also able to bolster their negotiating power.
As the pandemic has often highlighted insufficient inventory balances and supply chain disruptions, there is a growing shift from Just In Time (JIT) to a Just In Case (JIC) inventory model. JIT operations carry inventory as needed, whereas JIC operations hold a reserve of goods in preparation for a sudden increase in demand or supply chain disruption.
ABL is able to provide funds based on a company’s existing assets, but growing inventory further eats into cash flow and causes a longer DIO. Whether it is prompted by larger minimum orders or a consequence of vendor-managed inventory (VMI), a combination of solutions can be necessary. ABL fails to solve for this inventory burden because of the hard limits on inventory advance rates in the borrowing base formula.
Where SCF is able to stand apart from ABL is in allowing a company to shorten its cash conversion cycle (CCC) by improving Days Payable Outstanding (DPO). ABL is only able to solve for Days Inventory Outstanding (DIO) and Days Sales Outstanding (DSO) without contributing to working capital improvements upstream.
Therefore, companies that utilize both ABL and SCF in their working capital strategy maximize liquidity.
Traditional lenders lack the technology to interact in real-time with their clients’ supply chains, often remaining more conservative with lending limits as a consequence.
Harbor is able to fill this funding gap for their customers. The purchasing management platform shows exactly what is being financed, at what value and where the goods are. Based on these insights, Harbor is able to fund trade operations with more comfort than traditional lenders and is able to provide longer payment terms
The new way to Finance Trade
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